Deal Innovations In Mergers And Acquisitions: Do Go-Shop Provisions Create Real Benefits?

Transcription

1 Wayne State University Wayne State University Dissertations Deal Innovations In Mergers And Acquisitions: Do Go-Shop Provisions Create Real Benefits? Chenguang Shang Wayne State University, Follow this and additional works at: Part of the Finance and Financial Management Commons Recommended Citation Shang, Chenguang, "Deal Innovations In Mergers And Acquisitions: Do Go-Shop Provisions Create Real Benefits?" (2014). Wayne State University Dissertations. Paper 918. This Open Access Dissertation is brought to you for free and open access by It has been accepted for inclusion in Wayne State University Dissertations by an authorized administrator of

2 DEAL INNOVATIONS IN MERGERS AND ACQUISITIONS: DO GO-SHOP PROVISIONS CREATE REAL BENEFITS? by CHENGUANG SHANG DISSERTATION Submitted to the Graduate School of Wayne State University, Detroit, Michigan in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY 2014 MAJOR: BUSINESS ADMINISTRATION Approved by: Advisor Date

3 COPYRIGHT BY CHENGUANG SHANG 2014 All Rights Reserved

4 ACKNOWLEDGEMENTS I would like to express my deepest gratitude to my dissertation committee chair, Dr. Sudip Datta, for his continuous help throughout my Ph.D. program. This dissertation would not have been possible without his guidance and persistent support. I would also like to thank my dissertation committee members, Dr. Mai Iskandar-Datta, Dr. Scott Julian, and Dr. Robert Rossana, for their helpful comments and suggestions. ii

5 TABLE OF CONTENTS Acknowledgements... ii List of Tables... v Chapter 1: Introduction Background Organization of the Dissertation... 4 Chapter 2: Go-Shop Provisions How Do Go-Shop Provisions Work? Literature Review... 9 Chapter 3: Hypotheses Development Wealth Effect Hypotheses Initial Bidder Behavior Hypotheses Deal Outcome Hypotheses Chapter 4: Data, Sample Formation, and Descriptive Statistics Chapter 5: Empirical Findings Determinants of Go-Shop Provisions Addressing Potential Endogeneity Univariate Wealth Effect Multivariate Wealth Effect Initial Bidder Behavior: Changes from the Initial Offer to the Final Offer iii

6 5.6. Initial Bid Success Post-Bid Competition Robustness Check Limitation Chapter 6: Conclusions Appendix A: Go-Shop Provision Example Appendix B: Variable Definitions Appendix C: Correlation Table References Abstract Autobiographical Statement iv

7 LIST OF TABLES Table 1: Descriptive Statistics of Go-Shop Deals Table 2: Go-Shop Deal Characteristics Table 3: Determinants of Go-Shop Provisions Table 4: Wealth Effect Univariate Analyses Table 5: Multivariate Regression of Target Announcement Returns Table 6: Multivariate Regression of Bidder Announcement Returns Table 7: Multivariate Regression of Synergy Table 8: Multivariate Regression of Premium Table 9: Initial Bidder Behavior: Changes from the Initial Offer to the Final Offer Table 10: Initial Bid Success Table 11: Post-Bid Competition Table 12: Propensity Score Matching v

8 1 Chapter 1: Introduction 1.1. Background Deal innovations in mergers and acquisitions have occupied a prominent place in finance research. The importance of understanding the efficacy of new deal-making devices and identifying the beneficiaries of such deal provisions has attracted the attention of researchers. Prior research in this area has focused on deal protection devices, such as termination fee provisions and lockup options (see e.g. Bates and Lemmon, 2003; Burch, 2001; Officer, 2003). Along with the private equity boom in the mid-2000s emerged a new M&A deal technology the go-shop provision. This newly invented provision allows the target firm to actively solicit superior offers after an initial merger agreement is signed with the initial bidder. As the go-shop provision was used in some recent prominent merger deals such as Lear, Topps, J.Crew, and Dell, it has attracted much attention from the practitioners and academics in law. However, despite the ongoing debate on the use of go-shop provisions in corporate takeover activities, we still do not know the effectiveness of this relatively new deal-making device or who truly benefits from these provisions. While researchers have discussed the impact of goshop provisions from the legal perspective (Bloch, 2010; Denton, 2008; Morrel, 2008; Sautter, 2008; Subramanian, 2008), most of these studies are qualitative, use a small sample of go-shop deals, conduct mostly univariate analyses, and do not reach an agreement on the effectiveness of go-shop provisions in merger agreements. Subramanian (2008) also examines target firms stock price reaction to acquisition announcements in go-shop deals. 1 To advance our understanding of the overall wealth effects of go-shop provisions in corporate acquisitions, it is important to shed light on the impact of go-shop provisions on the wealth of targets and bidders, and thereby 1 Recent working papers by Jeon and Lee (2013) and Antoniades, Calomiris, and Hitscherich (2013) also examine target stock price reaction to acquisition announcements for go-shop deals.

9 2 provide evidence on the synergies associated with such deal provisions. To the best of my knowledge, this is the first study to do so. I also provide evidence on how go-shop provisions affect the initial acquirer s bidding behavior. Previous literature almost exclusively focuses on the impact of go-shop provisions on the target in soliciting superior offers from potential buyers, but overlooks the possibility that the inclusion of go-shop provisions in merger agreements may exert influence on initial bidders as well. Arguably, the initial bidder has the incentive to protect the deal in which it has invested a substantial amount of time, money, and due diligence effort. This study examines how the use of go-shop provisions influences the initial bidder in the post-signing period. In this context, I document how initial bidders react to the inclusion of go-shop provisions and identify the goshop deal characteristics that influence the initial bidders. A detailed examination of hand-collected go-shop deal parameters allows me to identify which characteristics are important in determining the wealth effects to the deal participants and deal outcomes. These go-shop characteristics include the length of the go-shop period, the number of potential buyers contacted during the go-shop period, the number of confidentiality agreements between the target firm and potential buyers, and the presence of a bifurcated termination fee structure. Subramanian (2008) is the only study that examines these go-shop deal characteristics in a univariate setting for a relatively small sample of 48 go-shop transactions. Using a multivariate setting, my study sheds light on the usefulness and efficacy of these go-shop characteristics, as well as additional deal and target characteristics, on deal outcomes. My primary focus in this paper is the impact of go-shop provisions on deal outcomes and I address the issue of whether go-shop provisions are utilized by target managers to pursue private benefits or are used to protect the fiduciary interests of the target shareholder. To this end,

10 3 I investigate the effectiveness of go-shop provisions by empirically testing a series of hypotheses following two competing theories: (a) the window-dressing theory, and (b) the shareholder interest theory. The results indicate that go-shop provisions generally have significantly higher positive wealth effect on the targets as compared to no-shop deals, but the bidders wealth effect is similar to no-shop transactions. However, go-shop deals are associated with substantially higher deal synergies. I also document that the inclusion of go-shop provisions in merger agreements affects the initial bidders behavior in the post-signing period. Specifically, bidders under merger agreements with go-shop provisions are more likely to raise their initial bid offers. This suggests that go-shop provisions allow target firms to exert pressure on the initial bidders to obtain a better price on behalf of the target shareholders. Thus, go-shop provisions can be used as a bargaining device against the initial bidders. I also find that go-shop deals are significantly more likely to be terminated compared to no-shop deals. Go-shop deal characteristics are important determinants of the outcome of the deals. Specifically, the market seems to react positively to the bifurcated fee structure in go-shop provisions. The number of potential buyers contacted and the number of confidentiality agreements entered during the go-shop period play an important role in pressuring the initial bidder to raise the original offer price, while the length of go-shop period and the number of confidentiality agreements signed predict the initial bid success rate. This study controls for a variety of important firm and deal characteristics, as well as target firm governance quality but prior literature is mostly silent on this dimension. Heckman two-stage procedure and propensity score matching method are employed in this research to mitigate endogeneity concerns. The results are confirmed by these robustness checks.

11 Organization of the Dissertation The remainder of this paper is structured as follows. In Chapter 2 I provide detailed background information of go-shop provisions and review literature on related topics. Chapter 3 introduces the two hypotheses regarding the use of go-shop provisions: the window-dressing hypothesis and shareholder interest hypothesis. In Chapter 4 I describe my data and sample selection process. Empirical findings are presented in Chapter 5. Chapter 6 concludes. Appendices and tables are included at the end of the dissertation.

12 5 Chapter 2: Go-Shop Provisions 2.1. How Do Go-Shop Provisions Work? Go-shop provisions allow the target firm to shop for better offers from potential buyers after a merger agreement is signed with the initial bidder. This provision contrasts the traditional no-shop clause which prohibits target firms from soliciting superior offers or negotiating with potential buyers once a merger agreement is entered by both the target and the bidder, unless the target receives unsolicited offers that are deemed to benefit the target shareholders more than the original offer. In go-shop deals, target firms have the right to actively solicit better offers during the so-called go-shop period and may exchange confidential information with a potential bidder as long as the potential bidder signs a confidentiality agreement that is equivalent to the one signed by the initial bidder. After the go-shop period expires, the target is subject to the traditional no-shop clause. A potential buyer who has shown interest and submitted a proposal during the go-shop period is usually allowed to continue the negotiation with the target after the expiration of the go-shop period. A prominent recent go-shop deal is Dell s $24.4 billion going-private buyout proposed by Michael Dell, the Founder, Chairman, and CEO of the computer giant. Dell announced on February 5 th, 2013 that it had signed a definitive merger agreement under which Mr. Michael Dell, partnered with private equity firm Silver Lake Partners, will acquire the third largest PC maker in the world and take it private. The deal agreement contained a 45-day go-shop period during which Dell s board of directors can freely contact and solicit other buyers. Promptly following the announcement of the deal, Evercore Partners, one of Dell s financial advisors, began the go-shop process on behalf of the company at the direction and under the supervision of the Special Committee. During the 45-day go-shop period, Evercore contacted a total of 67

13 6 parties to solicit interest in pursuing a possible transaction. On March 22 nd, 2013, the last day of the go-shop period, Blackstone Group and billionaire activist investor Carl Icahn submitted their competing bids. However, both Blackstone and Mr. Icahn subsequently backed out of the rival bid. The change-of-control transaction was completed on October 29 th, The 1986 landmark decision of the Delaware Supreme Court in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. rules that in a sale-of-control transaction, the singular responsibility of the target board of directors is to maximize the wealth of the target shareholders from the sale. In compliance with the Revlon standard, courts evaluate the adequacy of the decision-making process employed by the target board and examine the reasonableness of the target board s action in light of the circumstances. Dealmakers have primarily relied on presigning public auctions in an effort to obtain the highest possible price for the target stockholders. A pre-signing market check allows the target firm to discover the highest price available in the market and therefore it has been regarded as the most efficient way to achieve the target shareholder value maximization objective. Since the bidder has invested a substantial amount of time and resources upfront in conducting the due diligence research in identifying and evaluating the target firm, the bidder in the traditional auction process has the motivation to lock down deals that have been made. Consequently, a no-shop or no-talk provision, which provides the bidders with a deal protection, has been commonly used in merger agreements along with other deal protection devices such as termination fees. In situations where the target firm has little or virtually no pre-signing market check, the board of the target firm is expected to conduct an alternative post-signing market canvas (a fiduciary out or window-shop) so that the target shareholders could receive the highest bid price possibly available.

14 7 In recent years, the Delaware courts have held that a full-blown public auction is not necessarily a requirement for change of control transactions for all corporations under Delaware law. Delaware courts attitude on a firm s sale process suggests that a pre-signing market check is no longer considered the only effective method for the target firm board to achieve the highest sales price possible on behalf of the target shareholders. Alternative sales processes are acceptable as long as there is evidence that the target board has fulfilled its fiduciary duties. The go-shop provision has become a popular and important deal-making device since In contrast to traditional no-shop provisions, go-shop provisions give target firms an opportunity to lock in the initial sale price as the floor on the value of the company, while allowing the firm to actively solicit better offers during the go-shop period, which typically ranges from 30 to 50 days. The offer made by the initial bidder generates new information and may be used as a reference point for potential buyers, making the target more attractive and marketable. In case a superior offer emerges during the go-shop period and the target board decides to accept the superior offer price and terminate the original agreement, the target usually only needs to pay a reduced break-up fee, rather than the full amount, to the initial bidder. Although a public auction is believed by some to be the most efficient market canvass process, Boone and Mulherin (2007) use novel data to show that there is no significant difference between publicly auctioned deals and privately negotiated deals in the wealth effects for target shareholders. In addition, it may not always be feasible for the target to run a full-blown auction to extract the best possible price for the target shareholders before a definitive merger agreement is entered. A target firm may find a go-shop provision appealing when it is important to reach a deal quickly or when there would otherwise be a significant possibility of losing a seemingly attractive offer. For instance, Lear Corporation, a leading supplier of components to the

15 8 automotive industry, was approached by activist investor Carl Icahn in early 2007 with an interest of taking the company private. Mr. Icahn indicated that he would withdraw his offer if an auction occurred. At that time, no other potential buyers showed interest in a deal with Lear. As a result, Lear and Mr. Icahn entered into a merger agreement without a pre-signing auction or market check. Theoretically, the flexibility offered by go-shop provisions to solicit superior prices in the go-shop period is intended to encourage the target board to actively solicit competing bids from potential buyers. The target board can canvas the market and invite competing bids, if any, during the go-shop period. Because competition for a target is generally expected to result in a higher bid premium, the inclusion of a go-shop provision is perceived by some as good news. Besides, as suggested in Andersen (2008), go-shop provisions provide certainties to everyone as the initial deal is locked in without the risk to value or reputation that could result from a failed deal or a public auction. In the meantime, the go-shop provision provides the initial bidder with the advantage of pre-signing exclusivity. A one-on-one negotiation in the pre-announcement period helps the bidder avoid the risk of spending a significant amount of time and money in the auction process without a guaranteed outcome. Further, this exclusivity allows the bidder to close a deal much faster than if it has to compete in a public auction. Therefore, some previous studies argue that both the target and the acquirer can benefit from the go-shop provision (Bloch, 2010; Subramanian, 2008). Nevertheless, there are different voices about the go-shop provision as an effective market check device that increases target shareholder value (Sautter, 2008). The questions and doubts regarding the effectiveness of the go-shop provision are based on the observed low likelihood of the initial offer getting jumped during the go-shop period following the initial

16 9 announcement. Critics argue that because of the bidder s management retention policy and generous offer to the target s management team, the target manager may intend to sell the company to one particular bidder only, making the go-shop provision a window dressing practice that may not be beneficial to the target shareholders. In addition, many of the go-shop deals involve private equity firms and it is believed that private firms are not likely to challenge other private firms deals (the gentlemen s agreement between private equity firms), as noted in Houtman and Morton (2007). The go-shop periods are also claimed to be too short for potential buyers to conduct sufficient due diligence and propose competing bids. Moreover, goshop provisions may come with clauses that restrict particular buyers from entering bids or give the initial bidder matching rights. Such deal protections in the initial merger agreements may deter third party bidders from making competing offers Literature Review Several law studies discuss the role played by go-shop provisions in M&A deals since the emergence of the go-shop provision in the mid-2000s. Subramanian (2008) is the first empirical paper examining the effects of the go-shop provision. Using a sample of 48 go-shop deals in 2006 and 2007, Subramanian (2008) finds that go-shop deals yield more search than no-shop deals and target shareholders receive approximately 5% higher returns in pure go-shop deals than in no-shop deals. He concludes that the inclusion of a go-shop provision in a transaction on average benefits the target shareholders and may even lead to a win-win situation where the target firm gains from actively soliciting superior offers in the post-signing period while the bidder enjoys the highly valued exclusivity in the transaction. In the meantime, however, he warns that although the use of go-shop provisions allows the target board to fulfill its fiduciary

17 10 duties, a go-shop provision may not be beneficial to the target shareholders in management buyouts (MBOs). Bloch (2010) echoes Subramanian (2008) and argues that with a go-shop provision, the target has the option to lock in a floor value of the company while still being allowed to pursue better prices, and the bidder is provided with the highly valued exclusivity. Bloch (2010) also notes that the effectiveness of a go-shop provision depends on the deal protection mechanisms, the management involvement, how much effort the target board puts in soliciting superior offers, and whether the potential bidders are provided a legitimate opportunity to conduct due diligence and propose an alternative offer. Highlighting possible legal pitfalls that may arise from using go-shop provisions in acquisitions, Morrel (2008) points out that while go-shop provisions can be used to fulfill target boards fiduciary duties to obtain the best offer on behalf of target shareholders, target boards must utilize go-shop provisions in an effort to maximize target shareholder wealth. Sautter (2008) criticizes the Delaware courts support for post-signing market checks and contends that the go-shop provision is not a device that maximizes the wealth of target shareholders. In a recent working paper, Jeon and Lee (2013) find higher deal premiums and more competing bids in go-shop deals. Their findings generally support the proposition that goshop provisions reflect target manager s effort to fulfill the Revlon duties. Another recent working paper by Antoniades, Calomiris, and Hitscherich (2013) uses a sample of 306 cash deals to study the decision of adopting go-shop provisions in merger agreements and consider potential conflicts of interest and litigation risks. They argue that the go-shop option is not free by showing that target firms in go-shop deals receive lower initial premiums. The authors find a small but statistically insignificant improvement in attracting post-agreement bidders in go-shop

18 11 deals. Their theoretical framework has an ambiguous prediction about the effects of go-shop choice on target firm valuation. Evidence on the effects of go-shop provisions in existing literature remains inconclusive. This research is closely related to studies in deal protection devices such as termination fee provisions, toeholds, and lockup options. A considerable amount of attention has been given to research in this field (Bates and Lemmon, 2003; Betton and Eckbo, 2000; Burch, 2001; Officer, 2003). Termination fee provisions are included in M&A deals to require the target firm to pay a break-up fee to the bidder to compensate its labor, time, and expenses spent in the due diligence, in case the deal is not consummated. The findings in Bates and Lemmon (2003) and Officer (2003) show that the termination fees are at least not harmful, and are likely beneficial, to target shareholders. Betton and Eckbo (2000) find that pre-bid ownership of target shares reduces the likelihood of competition and target resistance and are associated with lower bid premiums. Another paper in the same vein as my study is Burch (2001). Burch (2001) examines the impact of lockup options granted to bidders and finds that although lockups serve as a competition deterrent for target firms, the lockup provision is associated with significantly higher returns to target shareholders. Burch (2001) concludes that managers use lockup options to enhance bargaining power rather than harm the shareholders. In a recent study by Boone and Mulherin (2007), the authors use a novel dataset to show that there is active takeover competition in the pre-announcement period and find that the wealth effects for target shareholders are comparable in auctions and negotiations. Since the use of goshop provisions is generally associated with private negotiation with particular single bidders while no-shop deals usually involve active auction processes, this research on the effectiveness

19 12 of the go-shop provisions from another angle empirically tests the conclusion in Boone and Mulherin (2007).

20 13 Chapter 3: Hypotheses Development Practitioners and researchers alike have been rigorously discussing the effectiveness of the go-shop provision in protecting the interests of the target shareholders since the emergence of this new deal technology in the mid-2000s. Success or failure in negotiating the terms of a goshop clause can mean the difference between maximizing the sale price and protecting your senior management and board or not, cautions Nicholas Unkovic, a partner at Squire, Sanders & Dempsey L.L.P. Consistent with this practical view on the effectiveness of go-shop provisions, previous law papers on the use of go-shop provisions argue that although this provision may be used as an effective market canvas device, target management incentives are an important determinant of the deal outcomes (see Bloch, 2010; Denton, 2008; Houtman and Morton, 2007; Morrel, 2008; Sautter, 2008; Subramanian, 2008). In line with both the professional and theoretical perspectives, I examine the effects of go-shop provisions in the context of two competing theories: the window-dressing theory and the shareholder interest theory. The core of the window-dressing theory is agency conflicts. The agency conflicts between the shareholders and managers have received considerable interest in previous literature (Jensen and Meckling, 1976; Jensen, 1986). Divergence of managers interests from owners objectives gives rise to agency problems. In the context of corporate mergers and acquisitions, the target manager may agree to a merger in pursuit of private benefits, such as a secured future position in the surviving company, even when the buyer s offer may not be the highest offer price available to the target firm (Hartzell, Ofek, and Yermack, 2004). 2 The window-dressing theory assumes that in go-shop deals, the target manager acts in his own interests and makes the decision to sell the target firm to a particular bidder without a full-blown market check in 2 It should be noted that neither Martin and McConnell (1991) nor Hartzell, Ofek, and Yermack (2004) find a negative relation between target shareholder gains and incumbent manager retention in the merged firm.

21 14 exchange for private benefits. Due to these potential private benefits, the management of the target firm may not have the incentive to run an efficient market canvas in the post-signing period since it has already decided whom it will sell the firm to. A particular bidder may be hand-selected because it promises the most private benefits to the manager of the target firm but not because the bidder offers a purchase price that maximizes the target shareholder wealth. Since the Delaware Court s decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. requires the target board of directors to make its best effort to obtain the highest price possible on behalf of the target shareholders in the sale of the company, the management of the target firm may be subject to litigations for failing to fulfill its fiduciary duty. As a result, the inclusion of a go-shop provision may be used merely as a window-dressing practice that provides the target board with legal protection in case of shareholder litigations (Bloch, 2010). In a recent study, Webb (2013) finds that the presence of go-shop provisions is negatively associated with institutional lead plaintiffs, suggesting that go-shop provisions could be used to mitigate litigation risks. In contrast, the shareholder interest theory presumes that target management acts in the best interests of target shareholders in change-of-control transactions. In situations where the target firm has limited pre-signing market check, if the target board determines that the initial bid offer is meaningful and attractive, it may accept the initial bidder s offer as a floor price and insist that a go-shop provision be included in the merger agreement so that the target firm can conduct a post-signing market canvas and actively solicit better prices from potential buyers on behalf of the target shareholders. If a competing bid emerges during the go-shop period and is deemed to be a superior offer, the target firm will accept it and terminate the initial deal by paying a (reduced) termination fee to the initial bidder. This way, the board of directors of the

22 15 target firm fulfills its fiduciary duties by thoroughly checking the market in the post-signing period and obtaining the highest price available to the target shareholders. To shed light on the effectiveness of go-shop provisions, I investigate the effects of this new deal innovation on the wealth of deal participants (bidder and target), the behavior of the initial bidder, and deal outcomes. Following the window-dressing theory and the shareholder interest theory, I develop hypotheses in each of these aspects of interest Wealth Effect Hypotheses The cumulative abnormal returns (CARs) around the announcement date are an important measure of wealth effects in M&A literature. Unlike previous literature that only examine the market reactions to target stock prices (Antoniades, Calomiris, and Hitscherich, 2013; Jeon and Lee, 2013; Subramanian, 2008), this study provides complete analyses of the wealth effects of go-shop provisions not only for the target, but also for the bidder as well as the synergy created by the transaction. The window-dressing theory implies that the go-shop provision is used by the target management as a mechanism to expropriate wealth from the target shareholders. If this is true, the market should view the go-shop provision as bad news and therefore should react negatively to the announcements of go-shop deals compared with no-shop deals. However, if the go-shop provision is an effective market canvas device for the target board to obtain the highest bid price for the target shareholders, the market reaction for target firms in go-shop deals should be at least at par with that for no-shop deals. The above discussion leads me to propose the following alternative hypotheses: H1a: Target firms in go-shop deals receive lower CARs compared with target firms in no-shop deals.

23 16 H1b: Target firms in go-shop deals receive CARs that are no lower than target CARs in no-shop deals. As the other party involved in the deal, the bidder is likely to be able to purchase the target firm at a discounted price if the go-shop provision is abused by target managers to pursue private benefits. The lower acquisition premium paid by the bidder in go-shop deals should be accompanied by positive bidder stock price reactions. On the other hand, under the shareholder interest theory where bidders pay fair premiums to target firms whose management actively solicits the highest price available for the target shareholders, bidders stock price reactions should be no different between go-shop and no-shop deals. This discussion leads me to propose the following hypotheses: H2a: Bidders in go-shop deals receive higher CARs compared with bidders in no-shop deals. H2b: Bidders in go-shop deals receive no higher CARs compared with bidders in noshop deals. Examining the wealth effect of both the target and the bidder allows me to take a step further to investigate the synergy created by the target and the bidder and answer the question how go-shop provisions affect the overall value generated in change-of-control transactions. The synergy created between the target and the bidder is dependent on the CARs of the target and the bidder as well as the relative size of the deal participants (Bradley, Desai, and Kim, 1988; Wang and Xie, 2009). In analyzing the wealth effects of go-shop provisions, I also consider the premiums paid to the target shareholders. According to the window-dressing theory, the management of the target firm may have the incentive to sell the target firm at a discounted price to a particular

24 17 bidder in exchange for private benefits from the bidder. Therefore, according to the windowdressing theory, the premiums paid to the targets in go-shop deals should be lower than those in no-shop deals. On the other hand, as suggested by the shareholder interest theory, if the target management strives to obtain the highest price available to the target shareholder, the initial bidder has the incentive to prevent the initial bid from being competed since it has already put in a substantial amount of time, money, and effort in identifying the target and entering into an agreement with the target. As a result, the initial bidder may offer a reasonable amount of premium to the target firm upfront to fend off potential competition during the go-shop period. The above discussion leads me to propose the following hypotheses: H3a: Target firms in go-shop deals receive lower premiums than in no-shop deals. H3b: Target firms in go-shop deals receive premiums that are no lower than in no-shop deals Initial Bidder Behavior Hypotheses The implications of go-shop provisions to bidders remain undocumented in the previous literature. I examine the initial bidder behavior in go-shop deals. If target managers use the goshop provision as a window-dressing device, then they will not have any incentive to solicit superior offers. Consequently, the initial bidder will not feel threatened by the go-shop provision and therefore will not consider it necessary to raise the initial offer to protect the deal. On the other hand, if the go-shop provisions are, in fact, utilized by shareholder-friendly target boards to solicit better prices in the post-signing period, the use of this provision should exert pressure on the initial bidder to raise the original offer price to protect the deal. Based on the above reasoning, I propose the following two alternative hypotheses: H4a: Initial bidders in go-shop deals are unlikely to raise the original offer prices.

25 18 H4b: Initial bidders in go-shop deals are more likely to raise the original offer prices Deal Outcome Hypotheses Given the extended shopping hours, target firms in go-shop deals have the opportunity to check the availability of superior prices in the market and collect information and feedback regarding the value of the target firms from the potential buyers solicited. The intended purpose of the go-shop provision is for the target firm to find potential competing bids, if any, in the postsigning period and terminate the original deal if deemed necessary. I empirically examine the impact of the target firm s option to actively solicit better offers in the post-signing period on deal outcomes, specifically, the initial bid success rate and the post-bid competition. Based on the window-dressing theory, if a private deal is made between the target management and one particular bidder, the initial deal is more likely to be completed. Therefore, the initial deal success rate in go-shop deals should be higher than in no-shop deals. Additionally, since the target management does not have the incentive to solicit better prices, go-shop provisions may not receive more competing bids compared to no-shop deals as one may expect. The target shareholder theory, on the other hand, suggests that if go-shop provisions are included in merger agreements to maximize the target shareholders wealth in change-of-control transactions, they should affect deal outcomes differently. Specifically, if the target board makes its best effort to find superior prices in the market and collects information regarding the valuation and future prospect of the firm from the market during the go-shop period, the termination rate of initial bids in go-shop provisions should be higher. 3 Besides, in situations where the target firm has limited opportunities to canvas the market prior to the initial bid agreement, more competing bids should emerge during the post-bid period in go-shop deals than 3 The frequently observed bifurcated (reduced) termination fee structure in go-shop deals would also encourage termination of the original bid.

26 19 in no-shop deals, assuming the target board acts in the best interest of the target shareholders. The above discussion leads to the following two sets of alternative hypotheses related to initial bid success rate and competing bids: H5a: Go-shop deals have higher initial bid success rate compared with no-shop deals. H5b: Go-shop deals have similar or lower initial bid success rate compared with no-shop deals. H6a: Go-shop deals do not induce more competing bids than no-shop deals. H6b: Go-shop deals induce more competing bids than no-shop deals.

27 20 Chapter 4: Data, Sample Formation, and Descriptive Statistics M&A data are collected from Securities Data Company s (SDC) Platinum Mergers and Acquisitions database for the period between January 1st, 2004 and December 31st, The status of a deal is either completed or withdrawn. I require deal values to be available in SDC and greater than 1 million US dollars. I exclude all transactions labeled as spinoffs, recaps, self-tenders, exchange offers, repurchases, minority stake purchases, acquisitions of remaining interest, or privatizations (Bargeron, Schlingemann, Stulz and Zutter, 2008). A deal is dropped out of the sample if the acquirer owned more than 50% of the target firm prior to the transaction. Target firms are public firms which have non-missing stock price data reported by the Center for Research in Security Prices (CRSP) during the three days surrounding the announcement date of a deal and accounting data reported in Compustat for the fiscal year immediately preceding the announcement date. Go-shop deals are identified in the SDC database. The sample period starts in 2004 because the first go-shop deal in this database is recorded in that year. To verify accuracy, I read through SEC filings to identify go-shop deals. I found a total of 203 deals with this provision during the sample period. 4 Detailed go-shop deal information, such as the length of go-shop periods, number of potential buyers solicited during the go-shop period, the number of confidentiality agreements entered between the target and potential buyers during the go-shop period, and the presence of a bifurcated termination fee arrangement, is obtained from the SEC filings in EDGAR database or from online resources such as Lexis-Nexis and Google search, 4 Datasets obtained from SDC prior to February 2013 included 242 go-shop deals with US targets in the sample for the period between 2004 and However, due to a clean-up process conducted by Thomson Reuters in March 2013, the number of go-shop deals in SDC dropped down to 174 for the same period of time.

28 21 supplemented by a go-shop deal report prepared by Potter Anderson & Corroon, LLP. 5 An example of the language used in a go-shop deal is contained in Appendix A. My final sample consists of 1,963 M&A deals, among which 137 are go-shop deals. Several law papers have discussed the motivation of the management and boards that include go-shop provisions in merger agreements. Some argue that it is possible that target boards use go-shop provisions as a legal protection in case of shareholder litigations (Bloch, 2010; Sautter, 2008; Webber, 2013). In the meantime, a high quality board which acts in the best interest of target shareholders may adopt this provision to maximize the wealth of target shareholders in case a superior offer price emerges. Either way, it is critical to consider management incentives and board monitoring and advising quality in change-of-control activities when studying the effects of go-shop provisions. Therefore, in this study I control for target board characteristics which are absent from existing research on go-shop provisions. For management incentives, I use an indicator variable to represent management buyout deals (MBO) obtained from SDC. The direct involvement of the management in a buyout offers the manager incentives to pay the lowest possible price. In the recent Dell going private deal, the founder of Dell, Mr. Michael Dell, is one of the major parties involved in the $24.4 billion purchase, and his initial offer price of $13.65 per share was deemed to be too low, which agitated the shareholders of the company. 6 To control for board quality, I employ corporate governance measures such as target board size, the percentage of outside directors on the board, CEO duality, and board busyness (see Brickley, Coles, and Jarrell, 1997; Core, Holthausen, and Larcker, 1999; 5 A copy of the Potter Anderson & Corroon, LLP report on go-shop deals can be accessed at 6 In a recent lesser-known management buyout transaction, the Weiss family, the founding family of the American Greetings Corporation, offered to buy the second largest paper card maker for $17.18 per share. The announcement of the initial offer price set off shareholder outrage. The special committee and institutional investors negotiated vigorously over the price. The founding family was pressured to raise the bid price up to $19 per share, which allowed the deal to go through.

29 22 Fich and Shivdasani, 2006; Finkelstein and D Aveni, 1994; Yermack, 1996). These governance quality measures are captured using data from BoardEx Management Diagnostics Limited. BoardEx database is a private corporate research company that collects information on the board of directors and senior management. I also control for standard firm characteristics in the M&A literature. M/B is the target market value of assets over book value of assets. Leverage is the target s long-term and current liabilities divided by total assets. Ln(market cap) is the natural log of a target s market value of equity computed 42 trading days prior to the deal announcement. I use the variable run-up, calculated as the market-adjusted buy-and-hold return from 252 days prior to the bid announcement to 6 days prior to the bid announcement, to capture the target previous performance and information leak before the announcement (Bargeron, Schlingemann, Stulz, and Zutter, 2008; Masulis, Wang, and Xie, 2007). I note that in order to have a fair comparison between go-shop and no-shop deals and circumvent noise in subsequent bids, I examine the initial bids only and exclude follow-up bids from the sample. I only focus on initial deals because go-shop provisions are much more likely to appear in the initial deals than in competing bids (137 vs. 6). Further, in order to submit a competing offer proposal, the subsequent bidder generally needs to offer a premium higher than the original offer. In other words, the premiums in competing bids are conditional on the initial offer. Since the primary focus is on initial bids due to the clustering of go-shop deals in initial bids, I believe that it is better to compare premiums among initial bids. For the same reason, using only initial deals provides a cleaner setting when I examine the impact of go-shop provisions on the behavior of initial bidders and deal outcomes.

30 23 Table 1, Panel A describes the trend of the use of go-shop provisions in merger agreements over the period from 2004 to The use of go-shop provisions gained popularity during the mid-2000s private equity boom. Despite the decline in use in the late 2000s, the provision has been included in an increasing number of deals in recent years. In 2012, the last year of observation in my study, more than 13% of merger agreements contained go-shop provisions. Throughout the study period, on average about 7% deals included go-shop provisions in the agreements. [ Table 1 here ] Table 1, Panel B contains descriptive statistics for deal and target firm and board characteristics. Several deal and target characteristics are significantly different between the goshop and the no-shop samples. Target termination fees are more likely to be present in go-shop deals than in no-shop deals. The more frequent use of target termination fee provisions may indicate that the bidders in go-shop deals are particularly concerned about the completion of goshop deals because an effective target board will use the go-shop provision as a device to search for superior offers during the go-shop period. More than 80% of go-shop deals are financed by 100% cash, compared with 58% incidence in no-shop deals. The high percentage of pure cash transactions in go-shop deals may be due to the fact that many go-shop deals involve private equity firms. While 6.6% of go-shop deal buyers possessed a toehold before the bid announcement, only 3.2% of no-shop buyers owned more than 5% of the target s outstanding shares prior to the acquisitions. Public bidders tend to use no-shop provisions more than go-shop provisions, consistent with the finding in previous research that go-shop provisions appear often in deals with private equity involvement (Subramanian, 2008). Go-shop deal bidders are less likely to be in the same industry as the target defined by Fama-French 12 industry classifications.

31 24 Existing studies have shown that management involvement in M&A activities can give rise to severe agency problems, and it may affect the effectiveness of go-shop provisions (Hafzalla, 2009; Bloch, 2010; Perry and Williams, 1994; Subramanian, 2008). I use MBOs as a proxy for management incentives and agency conflict in this study (DeAngelo, DeAngelo, and Rice, 1984). The univariate analyses show that go-shop provisions are more frequently included in MBO deals. However, it is not clear at this point whether this provision is used by the target board to protect the target shareholders or is used to shield the self-interested management from potential litigations. A fiduciary-out provision in a merger agreement allows the target board of directors to terminate a deal if an unsolicited superior offer emerges. Some critics regard this provision as a passive form of fiduciary effort by the target board to protect the target shareholder s interest (Sautter, 2008). 7 I find that go-shop deals are more likely to be coupled with fiduciary-out provisions than no-shop deals. Firms with smaller sized boards are more likely to include go-shop provisions in their merger agreements. There is some evidence that CEO power, proxied by CEO duality, is associated with the use of go-shop provisions in merger agreements. Firms whose CEOs do not also hold the title of chairman of the board are more likely to install go-shop provisions in change-of-control transactions. The differences in characteristics between go-shop deals and no-shop deals are confirmed by Pearson correlations presented in Appendix C. Go-shop deal characteristics, which are believed to be closely related to the effectiveness of go-shop provisions in benefiting the target shareholders (Subramanian, 2008), are reported in Table 2. Panel A of the table shows the statistics of detailed go-shop deal characteristics, namely, 7 A target firm may employ both go-shop provision and fiduciary-out provision in the merger agreement. For instance, the Topps merger agreement states, the terms of the merger agreement allow our Board to exercise its fiduciary duties to consider potential alternative transactions, including if it believes that an unsolicited acquisition proposal it receives after the conclusion of the go-shop period is reasonably expected to result in a superior proposal.

32 25 the length of the go-shop period, the number of potential buyers solicited by the target firm during the go-shop period, the number of confidentiality agreements entered into between the target and potential buyers, and the presence of bifurcated termination fees. Under the shareholder interest theory which suggests that go-shop provisions are an effective post-signing market check device, the characteristics of go-shop deals should have significant impact on the outcome of deals. A longer go-shop period is generally preferred because it allows more time for the target board and its financial advisors to solicit potential buyers. The number of potential buyers contacted by the target board and the number of confidentiality agreements entered by the target and potential bidders during the go-shop period reflect the effort made by the target board searching for superior offers. Theoretically, the likelihood of obtaining a higher bid offer should increase in the number of potential buyers contacted and in the number of confidentiality agreements signed during the go-shop period. A majority of the go-shop deals contain a bifurcated termination fee structure, which permits the target firm to pay a reduced termination fee in case the deal is terminated by the target board during the go-shop provision. The bifurcated termination fee structure is supposed to encourage the target board to solicit better prices during the go-shop period. The average length of go-shop periods is days with a median of 37 days, consistent with the findings in previous research. 8 A target board and its financial advisors on average solicit potential buyers during the go-shop period and enter confidentiality agreements with potential buyers who are interested in accessing the private information of the target firm. These numbers are higher than those reported in Subramanian (2008) due to the fact that the number of solicited buyers and confidentiality agreements signed kept growing over 8 Subramanian (2008) reports an average go-shop period of 38.4 days and a median of 40 days, while Houtman and Morton (2007) document an average go-shop period of 33 days prior to 2007 and 42 days in the year of 2007.

33 26 the period between 2004 and % of the go-shop agreements contain bifurcated termination fee provisions, allowing the target to pay a reduced amount of breakup fee in case of a termination of the initial deal during the go-shop period. [ Table 2 here ] Panel B in Table 2 presents the Pearson correlations between the go-shop characteristics. The length of go-shop periods are positively related to the number of bidders solicited and the number of confidentiality agreements entered between the target and potential buyers. Deals with longer go-shop periods are also more likely to contain bifurcated termination fee provisions. Active solicitations are positively associated with the number of confidentiality agreements entered during the go-shop period. It should be noted that although theoretically both the number of potential buyers contacted and the number of confidentiality agreements entered are indicators of the target board s effort of maximizing the target shareholders wealth, the number of confidentiality agreements may be a better and more accurate measure because the target board could contact many unsuitable bidders without getting any meaningful proposal or contact a few suitable bidders who are likely to submit superior offers. Potential bidders that enter into confidentiality agreements invest more time and effort into conducting due diligence than the window shoppers and therefore are more likely to challenge the initial deal.